Good debt vs.bad debt

Until recently, there was no such thing as good debt or bad debt; all debt was bad debt.

Owing money for any reason wasn’t a good thing and it was important to focus on paying off everything.

But now, we are hearing about having good debt and having bad debt. So what’s the difference?

Good debt is considered to be funds that you borrow to purchase an appreciating asset. Something that may grow in value such as real estate, a business or investments or a student loan to provide education which will result in earning a higher income.

Bad debt would be money you borrow to purchase a depreciating asset — cars, boats, clothes, consumables — or something that you can’t afford. Something that quickly loses value or doesn’t generate any revenue. It is most likely at a higher interest rate and even if the rate is low today you should also factor in a higher rate to ensure that you can afford it in the future.

High interest rate credit card debt is considered bad debt. Credit cards are not evil if they are used prudently and balances are not carried over.

Mortgages are considered good debt because real estate generally appreciates over time although there are no guarantees. You are also borrowing at lower interest rates.

Home Equity Lines of Credit, which are a type of mortgage, can be either good debt or bad debt depending upon what they are utilized for.

If you are using your Line of Credit to purchase depreciating assets or using it for your day-to-day expenses, it would be considered bad debt. Consolidating your high interest credit card debt into a Home Equity Line of Credit would be ‘good’ as there would be a significant lowering of the interest rate.  

Car loans would be bad debt as you are purchasing a depreciating asset but unfortunately the reality is that this is the only way that most people can afford a vehicle.

The best thing to do is pay cash or as much cash up front for a car as possible. Does everyone really need a fancy, new car?

Pay-day loans or cash advance loans are definitely bad as the interest rates and fees are astronomical.

In reality, it can be argued that no debt is good debt, but used in moderation and with an educated approach, debt can assist in many things.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.